Pedro Videla: The Peril of Too Big to Fail

IEO's December edition tackles bailouts, QE2 and economic reform

"The single most important lesson of this crisis is we have to end the 'too big to fail' problem,"said Fed Chairman Ben Bernanke to the Financial Crisis Inquiry Commission last month.

"He is right", concurs Prof. Pedro Videla in the December edition of IESE's International Economic Overview, an exclusive service for the school's alumni. "'Too big to fail' costs taxpayers billions of dollars in bailouts, creates incentives to take on excessive risk, distorts the real economy and passes the cost of failures on to the public."

In his article, Videla laments the recent Irish bailout, noting that "this is not the first time that taxpayers have been asked to pay the bill. We have seen this before, from Long Term Capital Management in 1998 to AIG and Citigroup 10 years later. This is not how a capitalist society is supposed to function. As economist Allan Meltzer cleverly put it: "Capitalism without failure is like religion without sin; it does not work."

Videla calls for a regulatory framework that would allow both a competitive and innovative financial sector, while permitting troubled institutions to fail.

Also in this month's IEO, Prof. Alfredo Pastor discusses how QE2 was risky, but unavoidable, while Prof. Javier Diaz-Giménez discusses Spain's recent economic reforms and the need to take more radical measures.